A Level Playing Field No More

07/01/2011 | Mark R. Robeck and Emil J. Barth

Most regulatory agencies look for ways to extend their reach, often in response to events that directly affect matters squarely within their regulatory purview, but which involve transactions or practices on the edge of their jurisdictional reach. It is rare for any agency, in the face of challenge, to surrender jurisdiction over practices it already has been regulating for years without first exhausting all of its arguments for maintaining that jurisdiction.

That remarkable turn of events is exactly what recently happened at the Federal Energy Regulatory Commission (FERC) when, in a set of orders affecting the territory controlled by the California Independent System Operator (CAISO), FERC reversed its longstanding policy permitting generators to net against their positive electricity output their station power requirements—the electricity required by a generation station to start up its turbines, operate its machinery, and keep lighting, heating, air conditioning, and other equipment operating.

Last year, the U.S. Court of Appeals for the District of Columbia rejected FERC’s invocation of its authority over interstate transmission as a valid basis for FERC’s regulation of station power in CAISO. On remand, FERC held that the entirety of jurisdiction conferred upon it by the Federal Power Act (FPA) did not extend to the regulation of station power, but instead that station power was subject to the states’ jurisdiction over retail sales.

FERC’s decision stands to impair competition in wholesale power markets by leaving merchant generators exposed to high retail rates for the very product they produce. At the same time it leaves unaffected the practice of vertically integrated utilities supplying station power cost-free among their own generation facilities. Yet, the outcome reached by FERC was neither inevitable nor necessary, as FERC ignored the full scope of its authority to regulate the wholesale sales market, including station power.

A History of Station Power Netting

FERC’s station power netting policy was first established in a series of complaint and tariff proceedings following the period of widespread divestiture of generation facilities by vertically integrated utilities in the late 1990s and early 2000s. Before (and after) divestiture, vertically integrated utilities self-supplied their station power requirements. To the extent that a utility’s generation facility could not meet its station power requirements by directly siphoning off on-site power production, the facility received the necessary energy from the utility’s other generation facilities via its transmission or distribution facilities. If the utility was part of a centrally dispatched power pool, it could also lean on the pool’s then-available energy supplies. In each of these scenarios, the output of a utility-owned plant was simply calculated as gross output minus its station power requirements. No charge was assessed for power delivered to the plant from other facilities or from the power pool.

Following divestiture, and coinciding with the transformation of power pools to independent system operators (ISOs), these same formerly vertically integrated utilities began to treat their sold-off plants in a very different way when it came to station power, billing their new owners at retail rates for electricity taken off the grid, instead of permitting them to net against their output.

These retail electricity bills were not insignificant. For example, over a 16-month period in 1999 and 2000, Niagara Mohawk Power Corp. billed three NRG Energy Inc. generation facilities in New York over $8 million in charges for retail distribution and delivery services, not even including the actual wholesale cost of the power.

In response, independent generators filed complaints at FERC, requesting that the existing practice of netting be formally recognized and enforced in a way that permitted all generators to net, merchant and utility. At the same time, ISOs such as PJM filed tariff sheets with FERC to facilitate netting in the context of the wholesale power markets. The proposed approach was simple: All generators could net station power taken from the transmission grid against their output sold into the wholesale market.

In 2001, and repeatedly in subsequent years, FERC approved the ISOs’ station power tariff provisions and ruled in favor of merchant generators in their complaint filings. In its seminal station power order, commonly called PJM II, FERC held that:

When a generator self-supplies its station power requirements, the traditional practice of netting appropriately reflects the fact that there is no sale. . . . We emphasize that a generator may net against its gross output as measured over a specific time period . . . even though there may be occasions during that [time period] when gross output is less than station power requirements. (PJM Interconnection LLC, 94 FERC ¶ 61,251 at 61,891, 2001)

In other words, so long as a facility generates more power than it consumes during the time period selected to measure electricity generated and consumed (typically one month to coincide with the ISOs’ billing cycles), the facility is recognized as self-supplying station power. This holds true both when the facility is generating power and directly obtaining it from onsite, and when it is not generating power and the power comes from the transmission system. (See also PJM Interconnection LLC, 95 FERC ¶ 61,333, at 62,188 (2001) ("PJM III"): "[W]e historically have not considered the self-supply of station power by a generator with positive net output to be a sale between two different parties. Rather, the self-supply of station power in this circumstance traditionally is accounted for by netting, that is, the subtraction of station power requirements from gross output.")

And because no end-use sale occurs—only an exchange of output for input in the wholesale market—FERC concluded that the states did not have jurisdiction over the self-supply of station power.

The driving force behind FERC’s move to formalize the practice of netting for the modern wholesale power markets was fostering fair competition between the independent generators and the vertically integrated utilities for the benefit of ratepayers. As noted above, utilities were billing their former plants at retail rates for station power while at the same time netting station power for their own plants. Consequently, if the traditional practice of self-supply was not adopted for the wholesale markets, the utilities would have had a substantial cost advantage in producing power at their remaining generation facilities because they remained in a position to always avoid retail rates for station power.

Unlike merchant generators, these utilities do not need to depend upon ISO tariff provisions to net through wholesale market accounting. Instead, they would continue to supply station power "behind the market" among their generation facilities interconnected by the utility-owned transmission and distribution networks.

To level the playing field for generators, in PJM II and other orders, FERC made clear that "all generators that are self-supplying station power may net their station power requirements against gross output . . . regardless of whether it is owned by a vertically-integrated utility, an affiliate [thereof], or a merchant generator" to "better ensure comparable treatment" between merchant generators and vertically integrated utilities.

The utilities naturally took umbrage at FERC’s leveling of the playing field, and the fight to put netting provisions in place in the ISOs continued well past 2001. In an order on rehearing issued in 2004 concerning the New York ISO (NYISO), FERC found that the "potential for discrimination between incumbent utilities and merchant generators . . . still exists," and approved NYISO’s compliance tariff filing implementing netting over a monthly period (KeySpan-Ravenswood v. N.Y. Indep. Sys. Operator, Inc, 107 FERC ¶ 61,142, at P 66 (2004), ["KeySpan-Ravenswood IV"]). In doing so, FERC affirmed its netting policy announced in PJM II, again explaining that "[t]he discrimination we are aiming to forestall is between the former owners of the divested generation facilities and the current owners, who seek alternatives to the supply of station power solely from incumbent facilities so that they can more effectively compete for customer load with the incumbent utilities, to the benefit of ratepayers."

Following a challenge by New York utilities and the New York Public Service Commission, the D.C. Circuit sustained FERC’s NYISO orders (Niagara Mohawk Power Corp. v. FERC, 452 F.3d 822, D.C. Cir. 2006).

The Fight in CAISO, the D.C. Circuit’s Decision, and FERC’s Orders on Remand

Following rehearing, the integrated utility Southern California Edison Co. petitioned the D.C. Circuit for review of FERC’s orders on the grounds that FERC did not have the statutory authority to regulate station power. Southern California Edison essentially argued that the consumption of energy by a generator from the grid at any time during the netting period constituted a retail sale, and thus was subject to state-approved retail charges.

Despite FERC’s nearly 10-year-old policy of enforcing netting provisions and the D.C. Circuit’s approval of netting in Niagara Mohawk, the court sided with Southern California Edison and vacated FERC’s approval of CAISO’s netting tariff provisions (S. Cal. Edison Co. v. FERC, 603 F.3d 996, D.C. Cir. 2010). The court determined that FERC had failed to establish a statutory basis for asserting jurisdiction over station power, which it must do to require CAISO to adopt netting provisions and thus find that no retail sale takes place as a result of netting.

First, the court found that its earlier decision in Niagara Mohawk did not recognize an independent jurisdictional basis for FERC to assume authority over station power. Although essentially the same netting regime was upheld in Niagara Mohawk, the court distinguished it on the grounds that the petitioners in that case conceded that FERC had jurisdiction over station power and could approve certain netting arrangements. In the court’s view, such a concession obviated the need to consider the jurisdictional question, and the court had only addressed the reasonableness of the monthly netting interval approved by FERC.

More importantly, the court held that FERC’s jurisdiction over interstate transmission under the Federal Power Act, the only grounds FERC advanced in support of its actions promoting netting, did not provide a basis for regulating station power. The court held that FERC could properly require netting to determine whether any interstate transmission service was used to deliver station power to a generation facility and thus whether a transmission charge could be imposed. However, according to the court, FERC’s interstate transmission jurisdiction did not extend to the commodity such that it could impose the netting of electric output and input. And even if FERC permitted a netting regime to determine if any transmission service was used in the delivery of station power, and the states adopted a different or no period for the netting of the actual commodity, the court found that in this case no conflict of federal and state law existed because the power markets were unbundled and thus "transmission and power are procured in separate transactions."

Nevertheless, at the very end of its opinion, the court recognized that FERC has a strong policy rationale for approving the adoption of monthly station power netting provisions:

The Commission is rather obviously concerned about the competitive position of the independent generators vis-à-vis those utilities who still maintain their own generator capacity. Indeed, that appears to be the underlying policy reason that drives FERC’s opinions. But FERC has yet to explain why that general concern can be grounds to preempt the state’s authority to set the netting period for station power—i.e., the pricing mechanism—in the retail market or to allow utilities to impose consumption charges.

This statement all but invited FERC on remand to grapple with the question of whether its jurisdiction over wholesale sales was sufficient for it to regulate station power.

Notwithstanding, acting on remand from the court, FERC announced that "[i]n light of the D.C. Circuit’s decision . . . , we conclude that the Commission and the states can use different methodologies when the Commission determines the amount of station power that is transmitted on the Commission-jurisdictional transmission grid and the states determine the amount of station power that is sold in state-jurisdictional retail sales" (Duke Energy Moss Landing v. Calif. Sys. Operator Corp., 132 FERC ¶ 61,183, at P 16, 2010). No analysis in support of this conclusion was offered. Moreover, FERC entirely ignored the submissions of several independent generators and associations, which offered extensive analysis of how FERC’s wholesale sales jurisdiction gave it the authority to regulate station power.

Only on rehearing did FERC even acknowledge the wholesale sales arguments advanced by the parties to the remand proceeding. Yet, FERC hid behind a single footnote in the D.C. Circuit’s opinion, which stated that it did not "’see any stronger basis for FERC to rest on that ground’ [i.e., its jurisdiction over wholesale sales]," even though this jurisdictional basis was neither advanced before the court by FERC or briefed by the parties. FERC also claimed, incorrectly, that it had rejected wholesale sales arguments in earlier station power proceedings and would "not revisit those arguments here."

The End of Netting, or a Way Forward?

FERC’s rehearing order makes clear that it believes it is not compelled at this time to vacate CAISO’s station power netting tariff provisions as they apply to transmission charges, only that it has no jurisdiction to require that such provisions are used to determine the amount or pricing for station power ("We see no reason to reevaluate the justness and reasonableness of the current CAISO Station Power Protocol at this time."). Nevertheless, the stage has been set for a showdown between the utilities and independent generators over the netting of station power.

In this regard, the lack of analysis in FERC’s remand orders makes its reversal in policy susceptible to challenge in the future for two main reasons.

First, the D.C. Circuit did not mandate the result FERC reached, regardless of the footnote in its opinion stating that it did understand how FERC’s wholesale sales jurisdiction could support its regulation of station power. As noted above, this issue was not before the court, and the court did not have the benefit of briefing on the topic, which is reflected by the lack of analysis of the issue in the decision. Instead, the only jurisdictional avenue for FERC’s regulation of station power foreclosed by the court was invoking FERC’s jurisdiction over interstate transmission. (See S. Cal. Edison, 603 F.3d at 999: "It should be noted that although FERC insists that it can determine that no retail sale has taken place . . . it does not rest on its wholesale jurisdiction but rather only on its jurisdiction over transmission.")

Moreover, the court closed its decision with the recognition of FERC’s concern about competition in the wholesale power markets, suggesting that FERC would be better served by expressing its jurisdiction over station power in terms of the statutory jurisdiction it is empowered to exercise over wholesale power markets.

Second, contrary it its own claim, FERC has never grappled with the argument that its jurisdiction over wholesale power sales provides the authority to establish netting rules for self-supplied station power. The PJM orders cited by FERC addressed a completely different claim, namely that FERC could regulate station power in the circumstance when a generation station does not generate enough electricity during the netting period to cover its station power requirements and thus is not self-supplying its station power requirements. (See, for example, PJM III, at 62,286-87.) In those orders, FERC only concluded that "[n]othing the parties raised on rehearing persuades us that we erred in determining that we do not have jurisdiction over third-party supply of station power," that is, that station power that cannot be covered by and netted against a generation facility’s positive output. FERC did not address the argument that netted station power falls squarely within FERC’s wholesale sales jurisdiction.

Because FERC has failed to directly reckon with the argument that its jurisdiction over wholesale sales empowers it to regulate self-supplied netted station power, this argument may form the best basis in bringing a future challenge to FERC’s policy reversal.

The Wholesale Sales Argument

The FPA grants FERC exclusive jurisdiction over the sale of electric energy at wholesale, as well as the transmission of electric energy in interstate commerce. Its terms also make clear that this jurisdiction is not limited to only wholesale sales of energy but also encompasses any "rule," "regulation," or "practice" that affects or pertains to wholesale rates (16 U.S.C. § 824(b)(1) & 824e(a)).

Thus, while the FPA reserves to the states jurisdiction over local sales of electricity at retail, FERC retains jurisdiction over wholesale sales directly, and over those rules, regulations, and practices affecting or pertaining to the wholesale energy market, even if FERC’s exercise of jurisdiction may affect retail rates.

As a primary matter, FERC’s regulation of station power falls squarely within its wholesale energy market jurisdiction. Allowing a generating facility to net its station power requirements against its gross electric output is nothing more than allowing that facility to engage in a reverse or exchange wholesale energy transaction, which takes place entirely within the bounds of the wholesale energy market.

In its prior station power orders, FERC has recognized that any generating facility having a net positive output over the netting interval (typically one month) is self-supplying its own station power, not consuming energy generated by another facility. For example, in PJM II, FERC states that "[f]or . . . on-site self-supply . . ., the generator is using only its own resources." Thus, a self-supplying generator is taking back from the market some portion of the wholesale energy it supplied to the market in the first instance, in order to meet its station power requirements. This exchange is necessary and reasonable because electricity is a fungible commodity and is neither traceable nor storable on a large scale.

As a result, under netting, any quantity of power consumed by the generating facility from the grid that does not exceed the quantity it put onto the grid is, for all purposes, the facility’s own power. To be clear, the energy used to supply its station power requirements is the facility’s own, first delivered to and then returned directly from the wholesale market; it is not energy that comes from outside of that market, produced by another generator. This fully accords with FERC’s own observations: A generator that is net positive "is not causing another to incur costs associated with the usage of another’s generating resources that would warrant a form of consideration" because it is relying on its own power.

Moreover, netted station power falls squarely within FERC’s wholesale station power jurisdiction because the transactions that permit a generator to recoup some of its wholesale power takes place wholly within the FERC-regulated wholesale market, involving only the generator and FERC’s market authority. More specifically, these transactions are accounted for entirely through the mechanisms of the wholesale market approved by FERC for the relevant market area, using wholesale market pricing. (See, for example, Niagara Mohawk, 452 F.3d at 830, holding that FERC’s approval of the use of wholesale congestion pricing for station power is "reasonable." Also see KeySpan-Ravenswood IV, at PP 29-36, explaining how netted station power in the PJM and NYISO regions is accounted for in the market through congestion pricing.)

As such, the de facto cancellation of some part of a facility’s wholesale transactions and return of some wholesale energy for the purpose of self-supplying station power plainly falls within FERC’s "plenary" and "exclusive" jurisdiction over how the wholesale market is conducted. (See, for example, FPC v. S. Cal. Edison Co., 376 U.S. 205, 216, 1964.)

Not only does FERC have jurisdiction over netted station power as a primary matter, but it also has jurisdiction over station power as a "practice" that "affects or pertains" to wholesale energy rates, as conferred upon it by the FPA.

It cannot be disputed that how station power is treated and accounted for has a significant impact on the wholesale energy market and the rates for wholesale power that are ultimately passed through to consumers. FERC has found (KeySpan-Ravenswood IV, at P 66) that if a merchant generator had to pay higher retail rates for self-supplied station power, "[t]his would make the generator’s own energy uncompetitive when compared to energy sold by the local utility, with which merchant generators compete for load, with resulting harm to ratepayers."

Multiplied across all merchant generators in the wholesale market, subjecting only merchant generators to retail charges for station power would readily result in significant wholesale price distortions and further negatively impact wholesale sales by diminishing competition among generators and the development of new generation over time. (See, for example, PJM II, at 61,892-93, discussing the competitive disadvantage merchant generators would face in relation to vertically integrated utilities if assessed retail rates, and KeySpan-Ravenswood IV, at P 66, finding that the threat of discrimination persists.)

Thus, because of the direct and substantial relationship between the regulation of self-supplied station power and the necessity of ensuring the efficiency and integrity of the wholesale market, FERC’s station power netting policy is both a proper exercise of its jurisdiction over wholesale sales and over practices "affecting or pertaining" to wholesale rates.

And because of the specter of disparate, anti-competitive treatment of merchant generators by vertically integrated utilities, this conclusion is also fully consistent with the FPA’s mandate that the Commission rectify "unduly discriminatory or preferential . . . practices" affecting the wholesale energy market.

Conclusion

As a result of FERC’s reluctance on remand from the D.C. Circuit to confront the question of the extent of its wholesale sales jurisdiction, the promotion of competition in the wholesale power markets may face a serious setback. Independent merchant generators across the country may soon be deprived of netting their station power requirements and instead could be billed millions of dollars for electricity at retail rates.

This would put merchant generation at a competitive disadvantage to generation controlled by vertically integrated utilities, as those utilities would still be able to net station power requirements across their fleets. By avoiding retail charges for station power, the utilities will have a significant cost advantage over merchant generators, which in turn could lead to price distortions in the wholesale power markets and ultimately lead to higher electricity prices for ratepayers.

To avoid this outcome, merchant generators should continue to demand that FERC recognize the full extent of its jurisdiction over the wholesale power market and return to its policy of enforcing netting rules permitting generators to net their station power requirements against their positive electricity output in the wholesale power markets.
—Mark R. Robeck is a partner in the Houston office of Baker Botts LLP. Emil J. Barth is an associate in the Washington, D.C., office of Baker Botts LLP. Robeck and Barth have advised generators on FERC’s station power policies. The views expressed in this article are those of the authors and do not necessarily reflect the views of the firm or its clients.

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